Fibonacci tools are constantly used by Forex traders. You should know them as the back of your hand because many analysts use these tools to identify levels of support and resistance or predict the potential reach of price movement.
Before talking about the Fibo tools themselves, we decided to introduce you to the man who developed them: Leonardo Fibonacci. In his book “Liber Abaci” (1202), the scholar studied the growth of an idealized population of rabbits sequentially. He was able to discover a simple series of numbers (0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.). Each number in this sequence is the sum of the two preceding ones. One wonderful thing is that the reasons for these numbers correspond to the natural proportions of things in the universe. Different trades on the market are often consistent with the Fibonacci ratios.
The most important Fibo ratios are 161.8% (89/55 = 1.618 – the “golden ratio”), 61.8% (55/89 = 0.618) and 38.2% (obtained by jumping 1 sequence in the division, for 55/144 = 0.382). You can find several Fibonacci tools in your trading terminal: retraction, expansion, fan / fan, arcs and timelines. All of these tools are based on Fibo reasons.
Fibonacci levels are very attractive because:
- They are geometric numbers: very pleasing to the human eye.
- They are objective price benchmarks (they eliminate subjectivity if used correctly).
Among the Fibonacci tools, we say that the most useful for traders are the retraction levels and Fibo expansions (also referred to as extensions).
Retraction of Fibonacci
The main purpose of using Fibo retraction levels is to determine the size of the potential correction against the main trend.
How to apply the Fibo retraction tool to the chart?
Choose the ‘Fibonacci retraction’ tool and draw a trend line linking 2 extreme points of a trend. For a bullish trend, you’ll draw this line from the minimum to the maximum. For a falling trend, you’ll draw this line from the maximum to the bare minimum. Then, 9 horizontal lines will appear automatically, crossing the trend line at the Fibonacci levels of 0.0%, 23.6%, 38.2%, 50%, 61.8%, 100%, 161.8%, 261, 8% and 423.6% (Fibonacci ratios, as described above).
These lines act as support and resistance: prices tend to consolidate near these levels before the correction ends (and the general trend is summarized) or continue (the price breaks one level of retraction and moves to the next, for example , from 50% to the 38.2% level). If the price shrinks more than 61.8% from the previous move (on a closing basis), it is likely that it will reach the beginning of the trend. The 50% retraction level is the most monitored level and is a common area to buy during a downtrend of a bullish trend, or sell if it is a retraction of a bullish trend.
When plotting Fibo levels, remember that you should use the top / bottom tips of the candle wicks to get the most accurate results.
You can use Fibonacci in different periods of time. If Fibo levels in different time periods converge, these levels become more important.
There are 2 ways to trade using the Fibo retraction tool:
Negotiate on each Fibo level. If the market started to actively go in the opposite direction, it opens up positions against the trend, aiming at the next Fibo level.
Expect prices to retreat from the Fibo level toward the main trend. The price is not always exactly at the Fibo level. In most cases, Fibonacci points to the support / resistance area. A confirmation signal at point C is required before a position is opened.
Watch out! Fibos can be treacherous …
Fibo Retractions are not 100% accurate. This happens not just because you plotted them incorrectly. Fibo levels are meant to give you a clue about the most lucrative entry / exit points, but they do not guarantee a positive outcome. To increase the chances of success in trading, use the Fibo retraction tool along with other technical indicators to achieve a higher probability of success.
Consider using Fibers with trend lines. Draw a trend line and then plot Fibo retraction. At the intersection point of these two tools, you can find the most favorable entry point.
If the 200-year moving average corresponds to the Fibonacci retraction of 50%, this level is likely to contain the initial market attack. This is a good place to profit or enter the market in the direction of the main trend.
You can also combine the Fibo retraction tool with candleholder patterns. Imagine that one day you see the price advancing, the optimistic candle (bull) is formed and closed close to a certain Fibo level. You are stumped. You want to know what will happen next – whether there will be more growth or not. Expect the formation of the next candlestick near the Fibo level. If it is a doji – an “exhausting candle” that tells you that the bullish trend is ending – it is likely that the recovery will not continue. Based on this signal, you can take the necessary actions to protect your earnings. Any reversal candlestick pattern near a Fibonacci level will probably mean that the price action will take a new direction.
In addition to the Fibo retraction, there is another useful Fibonacci tool that you should like and respect: the Fibo expansion, used to identify the most profitable exit levels.